JBLU - Spirit Airlines: Most Likely No Deal But Potentially 87.65% Upside

2023-03-07 12:30:11 ET

Summary

• The market believes the Spirit Airlines, Inc. - JetBlue Airways Corporation deal is as good as dead.
• If it fails, I'm not sure the sustained downside is all that intimidating.
• Meanwhile, there are interesting advance payments and the tiny probability of a miracle close.

Spirit Airlines, Inc. ( SAVE ) is likely being acquired by JetBlue Airways Corporation ( JBLU ) for $31 per share and change (more about that later). This heavily contested merger is receiving a lot of (anticipated) regulatory attention. Maybe it is receiving even more attention than anticipated. It was first announced on April 5, 2022.

From January 2023, SAVE shareholders get $0.10 per month from JetBlue as an advance payment. This is added to the $31 amount although JetBlue won't pay more than $32.15 in total.

Monday, SAVE dropped 8.76% as it appeared :

the Department of Transportation and Department of Justice are looking to halt the deal on the grounds that the merger would be anti-competitive, according to Bloomberg. The outlet said that a suit could be filed as soon as Tuesday by the DOJ.

I like that you can get $0.10 per month while fighting to get the merger through. If it gets through in some way, the upside is fantastic. The stock is trading at ~$16.52, while the offer is for $31. That's 87.65% upside. Even the monthly ticking fee is substantially similar to an 8% yield (beware of taxes, though).

The likely outcome (as per the market) seems to be for the deal to fail.

However, it appears as if that's at least partially priced in. The U.S. Global Jets ETF ( JETS ) as well as a number of competitors (used by Barclays as a peer valuation group in the merger agreement ) have traded down since early 22'. I have deliberately referenced January 1, 2022, below instead of the merger announcement date because something of a bidding war had been going on.

JetBlue and Allegiant Travel Company (ALGT) are the only peers that have done worse.

When I pull up valuations from a group of airline competitors (the above group + 1), the valuations of SAVE already appear to be in-line. There is not much sign of a merger premium except in the P/E line. Current elevated investments pretty easily skew a P/E line. I think EV/EBITDA, EV/sales, and even P/B are a bit more likely to be representative.

It has to be said that the earnings profile, especially 2023, has disappointed analysts since the deal announcement. That's roughly consistent with the price action we've already seen.

If this deal breaks, I'm not sure SAVE will need to trade down another 15%-20% on a sustained basis. There is also a break free, but it is admittedly small and won't help much.

Meanwhile, Spirit Airlines, Inc. shareholders receive $0.10 per month from JetBlue which helps quite a bit with downside protection especially if the legal fights are protracted. One of the problems with this merger is that the deal break risk is apparently so great that it vastly outweighs the probability the deal will go through. That means there is a lot of general market risk associated with holding the shares. Some of that risk could theoretically be offset by shorting a basket of airlines (like referenced above) against the long position. Alternatively, shorting an ETF like the U.S. Global Jets ETF could do that job.

Having said that, the JETS ETF seems much less volatile than some of the companies in the peer group. Theoretically, I see a long position in SAVE with a short position in JETS or peers as a market-neutral trade. There will be a downside on a deal break, but I expect the monthly ticking payments substantially offset it (the later the deal fails, the better). Meanwhile, there is the possibility of a massive ~87% upside for Spirit Airlines, Inc. if the deal surprisingly closes after all.

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